Down cycle concerns complicate risk management
05 FEBRUARY 2016 7:25 AM
Hotel investors looking to avoid risk need to be careful how they structure deals and be proactive, sources say.
LOS ANGELES—While many hoteliers are taking the position that there is still room for growth during the current cycle, sources say investors have to prepare for the worst-case scenario in order to properly manage risks.
Speaking at the recent Lodging Industry Investment Council meeting at the 2016 Americas Lodging Investment Summit in Los Angeles, sources told Hotel News Now that investors need to be looking at properties they can hold on to through the bad times.
“I think if you’re a hotel investor, now or any time, you have to prepare yourself and underwrite as if you have to hold a property through a down cycle,” said Steve Kisielica, principal at Lodging Capital Partners. “Values almost always come back in most markets, or at least the right markets. Where people get hurt is when they’re forced to sell at the wrong time. If you create a situation where you’ve got longevity to hold through that period, and they’re usually not that long, I think you’ve hedged your risk.”
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William Reynolds Jr., senior MD of MCS Capital, said hoteliers must follow up Kisielica’s approach by “scrubbing your existing hotels as an asset management fund.”
“You sort of go, ‘Do I need this? Do I need this? Do I need this?’” Reynolds said. “You have to find the balancing point for guest satisfaction between your ability to be great and your ability to manage your operating expenses. It’s not an absolute, but it’s a discipline.”
Jim Butler, chairman of the global hospitality group at Jeffer Mangels Butler & Mitchell, said waiting too long to take that approach—and essentially falling into the trap of thinking that good things in the industry will remain good indefinitely—is one of the riskiest things hoteliers can do.
“It’s almost an exquisite tension as you’re trying to get transactions done, at least in the mature end of the cycle,” Butler said. “Your expenses keep going up, unions are getting stronger and they want richer contracts, … but that all seems okay because your revenue is going up. But it’s really those long-term expenses that hurt when the downturn comes, and then you can’t cut quickly enough to bring things back into balance unless you’re prepared with a lot of money and capital.”
Sean Hennessey, CEO of Lodging Advisors, said hoteliers need to look beyond the industry while assessing risks.
“You need to look at the global factors,” Hennessey said. “The rising interest rate environment changes how you fund properties. The political structure or wage growth minimizes the extent you’re expanding non-core guest services.”
Hennessey also warned that investors in the hotel industry must be cognizant of supply from the sharing economy in major markets like New York City while assessing risk.
“The hotel industry needs to be particularly cautious about it because, in a decelerating market, the value proposition people perceive Airbnb offers them can become a lot more compelling,” he said.
Tom Prins, partner at Gemstone Hotels & Resorts, said hotel investors can mitigate their risks by specifically focusing on properties that aren’t already firing on all cylinders.
“On the acquisitions side, we really focus on assets where we can improve,” Prins said, specifically mentioning food and beverage and real estate development opportunities.
Prins also said developing strong partnerships centered on unique demand drivers can help reduce risk for an individual property. That’s what Gemstone managed to do with its hotel at Dollywood, he added.
“We tapped into something there that I think will survive any downturn,” Prins said. “And we’re the only hotel there.”
Mike Cahill, CEO and founder of Hospitality Real Estate Counselors, said he’s seen a shift toward low-leverage deals as the industry grows more averse to risk and debt.
“Part of the theory is, during a downturn, it’s really debt service that gets hotels,” Cahill said.